Insights and perspectives on the international financial system

Sovereign Credit Ratings and the Transnationalization published in the Economics E-Journal and publically available for download

Our discussion paper on “Sovereign Credit Ratings and the Transnationalization of Finance – Evidence from a Gravity Model of Portfolio Investment” has been accepted for publication by the Economics E-Journal, formerly Weltwirtschaftliches Archiv of IfW Kiel. Please find the summary of the website were you will find our paper available for download:

Abstract

It is a matter of debate in how far credit ratings contribute to allocative efficiency or to excessive volatility of asset prices and cross-border capital flows. Yet it is generally taken for granted that ratings play a significant role in the transnationalization of financial relations. This paper tests that hypothesis with data on sovereign credit ratings and foreign portfolio investment. A rating-related gravity model of finance is derived from the choice-theoretical framework of Okawa and van Wincoop (Gravity in International Finance, 2012) and estimated in three stages. At the first stage, the authors find that the introduction and evolution of sovereign ratings since the 1970s has affected inward portfolio investment in host countries. At the second stage, they examine to which extent sovereign ratings help to predict the degree of investors’ home bias, and whether they can account for the divergent dynamics before and after the global financial crisis. At the third stage, the authors look at the explanatory content of ratings for the determination of the size of bilateral portfolio investment. Evidence for a significant role of sovereign ratings is found at all three stages.

Data Set

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